CHARLES PERROW ALMOST HAD TO FIGHT HIS WAY into the Federal Reserve Bank of New York last September. Occupy Wall Street was in full swing nearby, and security at the door was unusually tight. The weather and the mood of the city were decidedly stormy.
Perrow had been invited to speak to a hundred senior New York Fed officials as part of the banks off-the-record Listen to Our Critics series, and he didnt exactly brighten their day. The 86-year-old Yale University professor emeritus of sociology has written widely about the dangers posed by complex systems, including his 1984 book Normal Accidents: Living with High-Risk Technologies, and he told the Fed audience that technological breakdowns in financial markets had become too commonplace too normal to be considered aberrations. In particular, he warned about the dangers of unleashing whiplash-fast trading algorithms and abstruse financial products on a tightly coupled global financial system.
In complex, nonlinear systems it is inevitable that at some time, two or more failures perhaps trivial, individually will interact in a way no designer could have anticipated and no operator can understand, he explained, squinting at his notes in a dim upstairs ballroom in the Feds neo-Renaissance headquarters. If the system is also tightly coupled, the failures will propagate and cascade through the system, even when everyone tries very hard to play safe.
Perrow may seem an unlikely market seer, but his theories have won him a following in financial circles. Richard Bookstaber, a former hedge fund risk manager now working in the U.S. Treasurys Office of Financial Research, drew from Perrows notions of normal accidents and tight coupling and the domino effect of failures cascading through interconnected systems in A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, his 2007 book that presciently laid out the elements of the global crisis that was about to unfold. According to Bookstaber, complexity breeds opacity, which, at best, can make it harder to guarantee orderly markets and, at worst, erect a smokescreen that can ruin transparency and abet fraud. Each innovation adds layers of complexity [that] cannot be easily disarmed through oversight or regulation, he says. As complexity increases, so do the odds of something unanticipated going wrong. ....